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International diversification, growth, and welfare with non-traded income risk and incomplete markets

  • Egil Matsen

The study asks how the potential benefits from cross-border asset trade are affected by the presence of non-traded income risk in incomplete markets. It is shown that the mean consumption growth may be lower with full integration than in financial autarky. This can occur because: the hedging demand for risky high-return projects may fall as the investment opportunity set increases, and precautionary savings may fall as the unhedgeable non-traded income variance decreases upon financial integration. It is also shown that international asset trade increases welfare if it increases the risk-adjusted growth rate. This is always the case in the model, but the effect may be close to negligible. The welfare gain is smaller the higher the correlation between the domestic non-traded income process and foreign asset returns.

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File URL: http://www.tandfonline.com/doi/abs/10.1080/09603100500120670
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Article provided by Taylor & Francis Journals in its journal Applied Financial Economics.

Volume (Year): 15 (2005)
Issue (Month): 15 ()
Pages: 1063-1072

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Handle: RePEc:taf:apfiec:v:15:y:2005:i:15:p:1063-1072
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  1. Svensson, L.E. & Werner, I., 1990. "Nontraded Assets in Incomplete Markets: Pricing and Portfolio Choices," Papers 477, Stockholm - International Economic Studies.
  2. Levine, Ross, 1996. "Financial development and economic growth : views and agenda," Policy Research Working Paper Series 1678, The World Bank.
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  8. Michael B. Devereux & Gregor W. Smith, 1991. "International Risk Sharing and Economic Growth," Working Papers 829, Queen's University, Department of Economics.
  9. Bernard Dumas & Raman Uppal, 1999. "Global Diversification, Growth and Welfare with Imperfectly Integrated Markets for Goods," NBER Working Papers 6994, National Bureau of Economic Research, Inc.
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